A rush to exit high-yield bonds is accelerating, driven by investor fears that the predicted rise in interest rates could trigger a mass sell-off too big for the market to absorb.

Investor flight

Managers including Vontobel, Schroders and Aberdeen Asset Management have been trimming their high-yield exposure in funds, amid concerns over investors’ ability to exit the asset class in a period of market stress.

David Walls, credit portfolio manager at Vontobel, said: “We believe it would be difficult for the market to absorb substantial outflows should investors ever decide en masse to underweight the asset class.”
Schroders chief executive Mike Dobson added: “We looked very hard at the position of our funds and have increased the cash levels in some of those funds to deal with that. We have been concerned about the potential risk for some time.”

Several managers said that while the fundamentals of the high-yield market remained sound – with corporate defaults still low – it could be harder to sell assets as interest rates rise, given that new capital rules effectively mean banks are now less able to take inventory onto their books.

Julius Baer completely sold out of its exposure to European and US high-yield bonds at the end of July, citing liquidity concerns in the market. The firm, which manages Sfr274 billion (about $303 billion), had been tapering its allocation to the sector from a high of 16% in early June.

Markus Allenspach, the firm’s head of fixed income research, said: “Our view is that you don’t get compensated for the liquidity risk you take.”

US high-yield bond funds and exchange-traded funds suffered record weekly outflows of $7.1 billion in the week ending August 7, according to data provider Lipper.

Investors and investment banks have expressed concern over the lack of liquidity for some time. Global policymakers and central bankers have recently added to the chorus, suggesting that rising interest rates could spur a sell-off.

Related

The lack of secondary market liquidity, along with previously strong inflows to bond funds, had helped inflate order books on bond issues, but bankers believe that period could be coming to an end.

Russell Schofield-Bezer, head of Emea debt capital markets at HSBC, said: “The supply and demand dynamic is hiding the impact of the lack of liquidity, but it is something that is starting to be on the radar screen of issuers.”

One head of debt capital markets at a rival said: “It doesn’t take a genius to work out that if there is a lack of liquidity, and the buying of these bonds is creating overinflated order books, if you turn that around to the flip side, you have a situation where these investors trim their positions… just where does that liquidity come from?”

The person added: “Will we see a crisis, as we did in 2008 and 2009, except it being more of a liquidity crisis, and a liquidity problem, rather than the issue of people being unable to value mortgage-backed securities and CDOs?

“Here we may have a situation where people can’t put a value on them because there is no secondary market liquidity.”